Chapter II: Paper Money
There are two kinds of people in America today —
those who have the privilege of creating money and those who have the
obligation to accept it. The privilege of creating money is given to a special
elite, those who own or control banks. Since it is illegal for an outsider to
go into the banking business, those already in that business have a special
privilege in law denied to the rest of the people. You can best understand how
money operates in our modern world — how bankers profit from the system without
producing any wealth, how they exploit the working people of the society, and
why they have come to have special privileges in law — by examining the history
of how paper money came into being.
In England, prior to about 1660, there was no paper
money. Money was gold or silver coin. However, this was not honest money. The
King was in the habit of taking the gold which came in to him and shaving a
little bit off from each coin and passing the new coins off as equal in value
to the old. Alternatively, he would melt the coins down and dilute the gold
with copper and mint new coins of the same sise but with less gold content. If
people refused to accept these diminished coins at equal value with the
original coins, then the courts (appointed by the King) would rule that the
value of money came, not from the objective value of the metal, but from the
declaration of the King; i.e., that the money was worth whatever the King, said
it was worth.
These rulings by the kings’ courts were called legal
tender rulings; that is, they determined just what could legally be tendered
(given) in payment. The shaved or adulterated money was called fiat money
because its value came from the fiat of the king.
As a product of the Reformation there began the widespread
accumulation of wealth, and, starting after 1660, some people began to look for
places of safekeeping. The practice started of taking one’s gold to a goldsmith
and paying him a small fee to keep it safe. The goldsmith in turn would issue
the owner of the gold a receipt, a small slip of paper promising to return his
gold upon demand. The process was the same as baggage checking today.
But unlike baggage receipts, the gold receipts soon
came to have a special use. If customer Charles wanted to make a purchase from
merchant Michael, then what was the sense of Charles taking his paper receipt
to the goldsmith, changing it for gold, and then coming back to make the
transaction? It was easier for Charles merely to pay for the merchandise with
the paper receipts. Then Michael could take these to the goldsmith and redeem
them for gold, if he wished.
Of course, by the same logic, Michael found it easier
to keep the paper receipts and use them to make his purchase from wholesaler
William. As long as everyone knew that the receipts were redeemable in gold on
demand, there was no need to actually redeem them, and it was more convenient
to handle the paper receipts than the actual gold. In this way paper receipts
for money began to circulate as money itself.
The trouble started when a goldsmith noticed: “Even
though people have the right to redeem their receipts for gold at any time, in
actual practice, very few of them do, and these are balanced off by new
deposits of gold coming in. If I print up more receipts than there is gold, no
one will know about it because it never happens that everyone comes in to
redeem all at once. And since the receipts circulate as money, I will have
extra money.” Beautiful.
And it sure beats honest work.
But the goldsmith didn’t quite get away with his
scheme. It was too blatantly something for nothing. It required a rather subtle
refinement. People objected when the goldsmith simply printed paper receipts to
add to his own wealth. But they did not know what to say when the goldsmith printed
paper receipts with which to make loans. By this act of lending, the ancient
Goldsmith became a banker; this was the birth of modern banking.
When people objected to his printing up receipts for
gold when he did not have enough gold to redeem the receipts, the
goldsmith-banker would reply: “But I do not keep these receipts. I lend them
out.” And the borrower would say: “And I do not keep the receipts. I employ
them productively in my business. And then I pay them back.” And the
goldsmith-banker would conclude: “And when he pays back the loan, I destroy the
receipts.”
But what the goldsmith-banker has failed to mention
is that he has profited from the interest on the loan. As William Paterson said
in his plan for the creation of the Bank of England, “The Bank hath benefit of
interest on all moneys which it creates out of nothing.” 1 This profit was unearned wealth, a gain made at the
expense of the rest of the community, which lost what the banker gained.
Unfortunately, the people of this time did not understand
interest. Economists and theologians, following the teachings of Aristotle and
the Bible, condemned all interest as unearned wealth. But since interest was
essential to the newly developing capitalist economy which was growing out of
the feudal system, most people just looked the other way and said, “We’re going
to do it anyway.” It was not until the development of the Austrian theory of
money and credit by Ludwig von Mises that people could understand that interest
was the price one paid for the use of goods over time, that everyone had a time
preference and preferred to have goods right away rather than to wait for them.
In simpler terms, a man who saves gives up something because be would prefer to
consume his wealth immediately. The saver also confers a benefit to the man to
whom he lends his savings because the latter can employ the capital which has
been saved to produce additional wealth. Interest is the reward to the saver.
It compensates him for his act of giving up, and it is a fair price for the
borrower to pay for the use of wealth-producing capital.
But while this applies to real capital, which has
been earned and saved, it does not apply to the paper receipts printed up by
the goldsmith-bankers. They did no saving; they did no giving UP. Their
interest represents what the medieval clerics thought all interest represented
— unearned wealth. Since the people of the 17th century did not understand
capital and interest, they were not able to distinguish between real capital
and valid interest on the one hand and bank created “capital” and invalid
interest on the other.
In the late 18th century it was common practice for a
banker to print four times as many paper receipts as he had gold. This means
that if a commercial banker received $1,000 in deposits, he was likely to print
$4,000 in receipts. If his interest rate on loans was 7%, then he did not get
7% x $1,000 = $70; he received 7% x $4,000 = $280. His real rate of interest
was 28%!
One of the real big-time bankers was the before
mentioned William Paterson. Paterson got some friends together and raised
72,000 in gold and silver to lend to the King, of England, who needed the money
to fight a war. But instead of lending him the money directly, Paterson formed
a bank and printed up paper receipts to the tune of 16-2/3 times his gold and
silver. He thus lent 1,200,000 to the King, and at an interest rate of 8-1/3%
per year, received interest payments of 100,000 per year.2
Here was a man whose total capital amounted to
72,000, and his annual interest payments were 100,000. This was a real rate of
interest of almost 140% per year.
But Paterson had gone too far. It was true that most
of the people would circulate the receipts and not demand gold. But there were
always a few people who would. And since Paterson had only 6% as much gold as
he needed, rumors began to circulate that he could not make redemption. Thus,
two years after his bank was opened people came to him in large numbers and
demanded redemption of their paper receipts. Paterson could not pay. He did not
have enough gold.
But Paterson had had the political foresight to lend
his paper receipts to the government. Since the paper receipts were needed to
fight the war, the government could not allow them to fail (as happened to
other goldsmith-bankers of the day). Paterson’s paper receipts were declared to
be legal tender. They were held by law to be just the same as the gold for
which they had stood. Thus was born a new kind of fiat money-paper money.
The old fiat money had been adulterated metal, for
example, 50% gold and 50% copper which was declared by legal tender enactments
to have the value of 100% gold.
It, at least, had the virtue of having partial value.
But paper money has no objective value. Its total worth is declared by fiat and
enforced by the power of the state. When people are left free to choose their
own money, they choose a commodity of objective value. For reasons pertaining
to the chemical characteristics of these metals, the most common choices are
gold and silver. In order to get people to accept paper money government must
force them to accept it by legal tender laws.
The first bankers had operated on the basis of fraud.
They promised to redeem in gold more paper notes than they could actually
redeem. They remained in business only so long as people did not ask them to
keep their promises. But with William Paterson, we can see the basic elements which
constitute our present aristocracy. The banker is constituted a special elite
person; he is given the privilege in law of having his paper receipts declared
to be legal tender money; and by this means, he acquires an unearned wealth.
This is the origin and basic essence of bank created
paper money. However, the system has undergone a considerable evolution to
arrive at its modern form. You have not been taught this in history class, but
the major political issue which has occupied this country since its inception
has been the issue of hard money, of objective value, versus bank-created paper
money.
From the time of its discovery, paper money was
extensively used in America, especially in connection with wars. Its most
famous use was the Continental currency of the Revolutionary War. But after
this currency had become worthless and the people had stopped using it, Congress
sent Thomas Jefferson on an inquiry to create a currency for the new country.
Jeffers on reported that the people had already
adopted a currency, the Spanish dollar (or piece of eight), a gold or silver
coin in common use in the Spanish colonies. Congress then adopted this coin as
the official money of the country, and, a few years later when the Constitution
was written, prohibited the enactment of legal tender laws.
The liberal, equalitarian viewpoint of the Founding
Fathers had led them to an extreme hard money point of view. But the bankers
were not ready to give up. They had suffered a defeat with the establishment of
an official gold/silver standard at the time of the writing of the
Constitution. But they still retained the privilege of issuing paper receipts,
called bank notes, far in excess of any gold or silver they had in their vaults
with which to redeem them. Typically, bankers would issue more and more paper
notes to maximise their profits. It was a matter of delicate judgement as to
how many notes one could issue before the public would become alarmed and
demand their gold. Periodically, the more greedy members of the fraternity
would issue to excess. Then there would be a run on that bank’s gold; it would
not be able to pay; and it would collapse.
The first attempt by the bankers to expand their
power was Hamilton’s proposal for a central bank. A central bank is one along
the lines of William Paterson’s institution. It is accorded a special status by
the government, and its primary function is to make the government loans.
Bankers found that a central bank offered them the following advantage. When a
small bank got itself into trouble by an overissue of bank notes and suffered a
run on its gold, the central bank would step in and lend the small bank gold to
tide it over the run. Thus protected by the central bank, the small banks, who
had previously expanded their note issue to three to five times their gold, now
felt safe to expand it substantially beyond that, with correspondingly greater
profits.
Jefferson, who understood the economic and political
implications of banking, was, in principle, a foe of all bank note expansion.
As he stated in a letter to Dr. Thomas Cooper on Jan. 16, 1814: “Everything
predicted by the enemies of banks, in the beginning is now coming to pass. We
are to be ruined now by the deluge of bank paper, as we were formerly by the
old Continental paper. It is cruel that such revolutions in private fortunes
should be at the mercy of avaricious adventurers, who instead of employing,
their capital, if any they have, in manufacturers, commerce and other useful
pursuits, make it an instrument to burden all the interchanges of property with
their swindling profits, profits which are the price of no useful industry of
theirs. Prudent men must be on their guard in this game of Robin’s Alive, and
take care that the spark does not extinguish in their hands. I am an enemy to
all banks discounting bills or notes for anything but coin.3” Jefferson was
unsuccessful in stopping the banks in the practice of issuing notes in excess
of their gold, but he decided to fight Hamilton on the issue of central
banking, which allows a far greater expansion of note issue. This fight between
the conservative forces, led by Hamilton, and the liberal forces, led first by
Jefferson and then by Van Buren and Jackson, was the major political issue of
the early 19th century (1791 to 1835). The Jeffersonian forces were ultimately
successful when Andrew Jackson vetoed the extension of the central bank’s
charter and was widely supported by the populace. However, the basic idea of
the evil of bank paper, per se, had not been communicated so the nation wound
up in the position of opposing central banking without really knowing why.
In addition to the use of notes, banking was refined
another step with the system of writing checks (officially called demand
deposits to distinguish them from savings or time deposits). Just as the banks
could issue more notes than they had gold, so they could create more money in
checking accounts than they had notes. Banking became a structure of pyramids.
At the base was gold, the real money. On top of that were three, four or five
times the quantity of bank notes printed on the assumption that only a few
people would turn them in for gold. And on top of that were several times the
quantity of demand deposits, created on the assumption that only a few people
would cash in their checks for bank notes.
The structure of banking in three phases is shown in
the charts on pages 12 and 13. Note that banking has always depended on
creating money in excess of its cash. Modern bankers, however, have the
advantage that for them cash is Federal Reserve notes. Thus their cash can be
increased at the will of the Fed.
This explains the nature of banking as it developed
in the 17th and 18th centuries. To relate this to our modern system of money
you must understand three additional developments:
The establishment of a uniform national currency. By
this act, passed during the Civil War, the notes of all banks were required to
be standardised. (Also, Treasury bills, whose redemption later became the
responsibility of the government, were issued.) It was the standardization
imposed by this act which allowed the bankers to later claim that their paper
notes were dollars. In legal and economic fact at this time a dollar was a
quantity of gold (or silver). Modern Americans do not understand that a dollar
was originally a unit of weight, like an ounce or a ton. (It was, in fact, 25.8
grains of gold, 9/10 fine.) The paper notes which passed in circulation were
merely receipts for dollars. But when these notes became standardised, the
bankers began to refer to the notes as dollars, a fact which ultimately eased
the transition to paper money.
The creation of a central bank. In the year 1900, the
country was solidly against the institution of a central bank, but as has been
noted it was Jeffersonian in form without really understanding the essence of
what Jefferson had been saying. A group of bankers were therefore able to put
across the enactment of a central bank by sophisticatedly disguising it as a
bank reform measure and then feigning opposition to their own proposal. This
central bank was the Federal Reserve System (actually a system of 12 banks)
created in 1913. The Federal Reserve immediately began to act very much like
William Paterson’s original central bank. That is, it expanded the note issue
and lent the money to the government to fight a war. The results were big
profits for the bankers.
Two important differences between the creation of the
Federal Reserve System and the creation of William Paterson’s Bank of England
should be noted. Paterson created his bank in competition with and in
opposition to the smaller private banks, and in fact the first rumors concerning
the solvency of his bank were spread by jealous smaller bankers. But the Federal
Reserve has never been in competition with American private bankers; it is
controlled by the private bankers and is used to serve their interests. Also,
Paterson found his war and took advantage of it. But the banking element which
manipulated the Federal Reserve System through an economically naive Congress
was a major reason for U.S. entry into World War I.
(3) The declaration of paper money as a legal tender.
After the bankers had lent their notes to the Government to finance World War
1, they turned and lent to the business community, thus sparking the business
boom of the 1920s. (The effect of bank paper in creating booms and depressions
will be discussed in Chapters III and IV.) This note issue reached its peak in
1929 when the banks found themselves over extended and were forced to contract.
In the period 1929-1933 there were runs on banks with people demanding their
gold. These runs reached a climax with the bank holiday of 1933. At that time
the Federal Reserve System did what William Paterson had done in 1696; it
refused to redeem its notes for gold. The Government then declared bank notes
of the Federal Reserve System to be a legal tender. This was the creation of
paper money in the United States.4
In our present banking system the first pyramid is
gone.
Standardised Federal Reserve notes have replaced the
standardised private bank notes, and since the former are a legal tender, there
is no need to back them with gold (although the nation still maintains a gold
supply). However, the second pyramid remains, and the nation’s banks now expand
their demand deposits on a base of Federal Reserve notes.
With the enactment of a legal tender law in 1933, the
basic system was created which is now leading to the formation of an American
aristocracy. The bankers and the Federal Reserve have, since that time, used
their privilege to create a quarter of a trillion paper dollars. The interest
which they have charged on this money represents wealth stolen from the
American people. This is the basis of the system. It is to protect this
income-producing privilege that the bankers are forced to expand their power
and constitute themselves an aristocratic class.
In the early days of paper money, profiteers and
adventurers arose who exploited the system for all it was worth. You will find
the story of Andrew Dexter, Jr., as reported in the “Democratic Press” in 1809,
an interesting example:
Each revolving year brings forth some extraordinary
novelty to excite wonder and gratify curiosity. Long as banks have been in
operation in various parts of the world, it was reserved for the present age,
so fertile in discoveries and improvements, to invent the ne plus ultra of
liberality. And accommodation in the tenor of a promissory note. And the most
remarkable feature in this affair, is that the discovery was not made in
London, Paris, Vienna, Philadelphia, New York, or Boston, but in a two-penny
village, called Gloucester, in Rhode Island, containing about a dozen houses.
In this village, immortalised by the invention, there was a bank established in
1805, of which the capital was composed of two thousand shares, of fifty
dollars each, amounting to 100,000 dollars. Of this bank, Andrew Dexter, Junr.
an illustrious speculator, borrowed the trivial sum of 845,771 dollars in their
bank notes, for which sum he gave his promissory notes, without indorser, in
the following improved form:
“I, Andrew Dexter Jr., do promise the President,
Directors, and company of the Farmer’s Exchange Bank, to pay them, or order
dollars, in years, from the date, with interest at two per cent per annum; it
being, however, understood that the said Dexter shall not be called upon to
make payment until he thinks proper; he being the principle stockholder, and
best knowing when it will be proper to pay the same.
I annex the amount of the
respective notes and the periods of payment, for the gratification of the
reader:
With the bank notes received by Dexter for these
notes of hand, there was carried on a stupendous scene of fraud and villainy.
They were employed in the purchase of property of every kind, by Dexter and his
friends: and as they made no scruple about price, they possessed’ themselves.
of many of the most valuable estates in New England, some of which had
descended from father to son since the first settlement of the country.
Hundreds, perhaps thousands of people deplore their fatal credulity, which
induced them to convert their property into this paper, not now worth a cent on
the dollar, which has reduced them from a state of affluence to beggary and
wretchedness.
The bank ceased its operations on the 27th of
February, 1809, with the enormous sum of specie in its vaults of eighty-six
dollars and fifty cents, which on accurate calculation, will probably pay a
farthing in the hundred dollars to his creditors. The legislature of
Rhode-Island at its last session appointed a committee to investigate the whole
of the nefarious transaction. The committee has published a luminous report for
the information of their constituents, from which this sketch is taken. 5
Such abuses outraged the public, and bankers realised
that some limitations on their note issues were necessary if the privilege were
not to be denied them altogether. Therefore, regulations were passed limiting
the amount of notes a bank could print in relation to its gold. These
regulations continue today except that today they limit the amount of demand
deposits a bank can create in relation to its Federal Reserve notes. Abuses
such as the above also show why banking has been limited to a special elite. If
everyone could create money, then everyone would, and the system would break
down.
Bank profits today thus depend heavily on the actions
of the Federal Reserve. If the Federal Reserve issues more notes, then banks
can use these notes as a base on which to expand their demand deposits, which
they do in a manner similar to the ancient goldsmith by making loans. These
additional loans brine, in additional interest, which is profitable for the
bank. In our modern world the Federal Reserve is very important for the banks.
It can make or lose them millions of dollars. The Federal Reserve in our modern
society has the magical power to create money. It simply prints a note, and
since its notes are legal tender, presto, it has created money.
In theory the Federal Reserve might print money for
any purpose. The head of the Federal Reserve might go into a restaurant, order
a steak dinner and then print up a Federal Reserve note to pay for it. But
traditionally the central bank has existed primarily for the purpose of lending
the government money. In practice the only time the Federal Reserve prints
money is when the Federal Government runs a budget deficit and needs to borrow.
When the Federal budget is in deficit, the U.S.
Treasury prints up pieces of paper called Government Bonds. A bond is nothing
more than an IOU. Then the Federal Reserve prints up pieces of paper called
Federal Reserve notes. A note is nothing but an IOU. Then these two agencies
exchange IOUS. 6 But since the legal tender laws
are deemed to have the magical power to make pieces of paper into money,
presto, money has been created.
This is how the Federal Government borrows money in
our present society. In reality our Government is bankrupt. The people do not
have enough confidence in the Government to lend it money. Were it not for the
Federal Reserve the Government could not borrow enough to meet the huge
deficits it runs. But the important thing to understand is that every time the
Federal Reserve creates money to lend to the Government, that money finds its
way into the banking system. (That is, it is spent, goes into circulation, and
is deposited in a bank.) Then it can be used as a base upon which to multiply
the bank’s loans (demand deposits).
According to present regulations (depending on the
type of bank) demand deposits can be increased by more than six times the cash
base; thus, for every dollar printed by the Federal Reserve, the banks can
create five times that amount in loans, receiving corresponding, interest
payments.
Banks, therefore, have a vested interest (in more
than one sense) in budget deficits. Since by far the biggest budget deficits
occur during war, banks have a vested interest in war.
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